Netflix run-up puts investors in a quandary

Analysis: Stock has surged past most of the high price targets

SAN FRANCISCO (MarketWatch) — Having watched the value of their holdings more than double over the last two months, Netflix investors are now grappling with the question of whether their enthusiasm for the video-rental firm’s business can justify the stock’s sky-high valuation.

Most of those gains came just last week, after Netflix
NFLX, +2.47%
reported much fourth-quarter results that were better than anticipated, turning a profit instead of an anticipated loss. The company also topped 2 million new U.S. video-streaming subscribers in the quarter, giving it 27.15 million such total subscribers. Those results also exceeded Netflix’s own targets for the period. Read more about what went into Netflix's quarterly results.

Reuters

Netflix shares surged more than 60% following its quarterly results, and now surpass most of Wall Street’s targets. Above is CEO Reed Hastings.

The results and forecast sparked a run-up that added 64% to the company’s market value by the end of the week. Netflix was last trading up fractionally to $163.30 by midday Tuesday.

The report also boosted sentiment on Wall Street, where at least four brokers upgraded the stock. Several more raised their price targets on Netflix by a significant amount, bringing the Street’s median target to $120, according to Thomson Reuters.

But the gap between the stock’s current value and most of the recently raised targets has put analysts in a bind. Such was the case for Carlos Kirjner of Bernstein Research, who raised his target price on Netflix to $125 a share from $71 on Monday, but left his market perform, or neutral, rating unchanged.

In his note, Kirjner said wrote in a “normal situation,” such a discrepancy between his target and a stock’s current price would result in a rating of underperform, or sell. “However, given how volatile the stock has been over the last few days — we think in large part driven by short-covering after the quarter — we will wait for the volatility to subside before deciding whether we should rerate it.”

Most everything involved with Netflix comes down to two things: the cost of acquiring content and the number of subscribers, who generally pay $7.99 a month to fund the company’s content-acquisition efforts. On the earnings call last week, Chief Executive Reed Hastings said there were no current plans to raise prices on subscription rates, and the company is looking for better content to help get to 50 million domestic subscribers.

Kirjner said he believes Netflix will be able to grow its domestic video-streaming revenue at faster rate than that of its content-acquisition expenses, and increase margins in the process. However, he values the domestic-streaming business at $53 a share, and the total value of the stock at $125 a share.

Even after four brokers upgraded the stock last week, to some the company still seems to be a wait-and-see story. According to data from Thomson Reuters, eight analysts currently rate the stock as a buy, while 20 rate the shares as neutral and six remain maintain a sell rating.

Wedbush Securities analyst Michael Pachter, one of the most critical of observers covering Netflix, used the company’s results and outlook to raise his price target on the stock to just $55 from $45 — and left his underperform rating unchanged.

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“We expect higher costs to result in erosion of the quality and quantity of Netflix’s content library over time, resulting in higher [customer] churn,” he wrote. Also, “we expect domestic-subscriber growth to slow or stall completely in the next few years.”

On the opposite end is Barton Crockett of Lazard Capital Management, who upgraded the stock to a buy rating last week and set a price target of $200 — the highest on Wall Street for Netflix.

Among the reasons for Crockett’s upbeat view were that “U.S. consumers liked the service more,” along with a 25% drop in domestic-streaming marketing costs. He said the results for the quarter “looked very solid globally,” while adding that new original content “looks poised to drive a dramatic step up in content visibility” for 2013.

“This swings the presumption from skepticism to optimism that Netflix can generate strong profit growth domestically, and repeat this around the world,” Crockett added.

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